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The Strength of Controversies

A second important trend revealed from the interviews was the nature of controversial issues. We asked respondents to discuss what they considered the more controversial issues raised in board meetings and how these issues are addressed. Two of the issues most commonly cited were personnel decisions and venture valuation. Controversy over personnel issues largely concerned the hiring and termination of key management personnel. Valuation controversies were salient when new investors were sought and when investors were considering options for exiting the firm, such as buyout, merger, or IPO. Such decisions are controversial in that theyoften involve a zero-sum renegotiation of previously settled issues. Further, while an existing contract generally provides the format for renegotiation it generally will not provide the substantive bases by which new conditions can be factored in. Not surprisingly, we observed in our interviews considerable variation in the amount of time spent in board meetings discussing and resolving key controversies over hiring/firing and valuation-related decisions.

Hiring/firing and valuation decisions increase the salience of goal conflict between decision makers. As such, they divert board attention from information processing, planning, and strategic decision making. Whereas other types of decisions may be reached more easily without one side or the other fearing that opportunism is motivating a board member's stance on an issue, personnel and valuation decisions often bring to the forefront the issues of goal conflict. From the perspective of agency theory, conflict over personnel issues can be understood by examining plausible utility schema for entrepreneurs and outside investors. When considering the addition, reposition, or removal of key personnel, entrepreneurs may be willing to trade off higher expected returns for greater assurance of venture survivability, for greater assurance that he/she will remain in control of venture management, for the ability to provide ongoing employment to a loyal friend, or for the possibility of discovering a path-breaking solution to a technical problem. Investors may be willing to trade off any of these for a more certain, relatively short-term return on capital invested. For example, in one of our interviews an entrepreneur complained that an investor brought on a "marquis player" into a top management position in order to obtain a more favorable IPO placement and that the venture had thus lost a capable manager for a short-term gain. In many instances investors complained that management was unwilling to remove ineffective personnel because of misplaced loyalty.

When the issues of obtaining additional equity financing or of selling the business to outside interests are raised by either side, often the specter of a more direct conflict of interest is immediately raised. For example, whereas it is in the best interests of the investors to value the venture as low as possible when the initial investment is made, it is in their interests to have it valued as high as possible later on. Consider the example of bringing new investors on board. Investors already on the board will attempt to value shares of the firm as high as possible; this is theoretically in the interests of management as well. However, insiders, motivated to ensure the survival of the firm, are apt to be more anxious about obtaining needed additional funds and would therefore be more willing to agree to a lower valuation to appease prospective investors. Again, because of the presence of conflicting goals, factions may emerge that impede the decision making process on controversial issues. In short, we expect that board decisions concerning personnel and valuation are likely to be more prolonged and potentially more acrimonious than other important decisions made by the board because they require a redistribution of power and wealth that may be seen as a zero-sum game.

Proposition 3: The board will spend more time and will experience greater acrimony in making decisions regarding personnel and valuation than other types of decisions.

When issues such as personnel hiring or venture valuation are raised, whether by insiders or outsiders, the threat of opportunism is likely to be more salient to board members. The suspicion that opposing board members may promote their self-interest at the expense of others
may undermine the value of discussions of controversial issues. That is, as boardmembers call into question the motives of opposing members, they are apt to call into question the legitimacy of arguments presented by opposing parties during discussion of controversial issues. This was manifested in our interviews by two entrepreneurs who, in describing conflict over valuation, characterized investors as "greedy." Another respondent, discussing the termination of a senior employee suggested that investors contrived an excuse to do so.

Trust may serve to discount suspicions of opportunism. When an individual trusts another party, the individual believes the other party is able to restrain his or her self-interests and seek mutually beneficial outcomes (Lind, 1997). Thus, trust would lead a board member to believe that opposing members with conflicting goals are capable of negotiating the issue to a mutually agreeable resolution. More specifically, trust should lead board members to more readily accept the arguments of opposing members at face value and listen to opposing opinions more openly. As a result, controversial issues should be resolved more rapidly and with less rancour. The establishment by the entrepreneurial management team of a pattern of fair dealing is apt to create a board more willing to trust managers' motives and more apt to reciprocate in kind when controversial issues subsequently arise. Therefore, fair conduct in the process of previous decision making should have an impact on the discussion of controversial issues.

Proposition 4: Fair decision-making procedures will serve to diminish the extent to which the board will spend more time and will experience greater acrimony in making decisions regarding personnel and valuation than other types of decisions.

The Mode of Decision Making

One of the most surprising findings from our interviews was how little actual decision making appeared to occur during board meetings. In most cases, decisions that were ratified during meetings had been resolved prior to the meeting. Decisions were typically made by consensus (achieved through interactions outside of meetings) and voting was largely perfunctory. Only rarely did respondents recall instances of split votes in meetings. This consensus mode extended to virtually every type of decision--even the replacement of the CEO. Similarly, we seldom heard accounts of board members acting on their authority against the wishes of other board members. We describe these strategies as forcing issues. Forcing issues is a means of decision making whereby one or more members invoke the contract, rules, or structure of the board to impose a decision. We believe forcing issues is a costly strategy that board members are reluctant to adopt, for it may undermine cooperative relationships and commitment to decisions. For example, one CEO stated that he chose to refrain from calling a vote on an especially divided issue. Although he believed the issue would be decided in his favor if voted on, he thought " would cost too much."

Given the potential costs of forcing issues, why would board members resort to such an extreme strategy? Fama and Jensen (1986) suggest that contract enforcement, a governance tactic of last resort, will only occur when the costs of not enforcing the contract are greater the than the high costs of enforcing (or rewriting) the contract. Thus, board members are likely to employ this strategy when they perceive non-compliance with the contract or anticipate a severe threat of contract violation. Agency theory would suggest that the perception or threat of non-compliancežor opportunismžis greatest when perceived goal conflict is high. This perception may be exacerbated by the impact that goal conflict has on the intensity of controversy: the longer the issue remains unresolved, the stronger the perception that opposing board members are non-compliant.
This sentiment was echoed in the responses of one investor who, as chairman of the board, forced a vote to fire a CEO who had several very loyal board members behind him. The Chairman believed that because the CEO needed to be removed for the survival of the firm, board members' steadfast loyalty to the CEO was tantamount to shirking their fiduciary responsibilities. In sum, because of the costs and problems associated with non-consensual decision making, only high levels of goal conflict on unresolved issues can lead board members to forcing issues.

Proposition 5: The greater the goal conflict, the more likely a board member will resort to forcing the issue.

The above discussion is not meant to suggest that board members will tolerate little goal conflict or are quick to infer that opposing members will be non-compliant. Such judgments are apt to be influenced by the level of trust that develops over time between board members. Indeed, given the conflict inherent in investor-owner relationships, the rarity of instances of forcing issues is a testament to the good faith and patience of board members. Resorting to the contract implies that conflicts cannot be resolved through interpersonal means. That is, forcing issues may be indicative a breakdown in the social relationship. Compromises to the social relationship between individuals in an economic relationship are likely to occur when principles of fair treatment in decision making are violated. A pattern of violations indicate that the decision maker will ignore the affected individual's interests in future decision making (Lind, 1997). Therefore, to resolve conflicting issues, the affected individual must resort to formal contractual obligations. Bies & Tyler (1993) found support for this reasoning in a setting which arguably represents the most extreme form of contract enforcement: litigation. They studied the intentions of individuals who felt they were the victims of mistreatment in employment that was legally actionable. They found that those who were treated unfairly prior to the incident in question were more likely to consider suing their employer.

Thus, the extent to which board members were treated fairly in previous decision processes should influence how they interpret their prospects for resolving issues. To the extent that they are treated fairly in previous interactions, board members are apt to believe that opposing members can be trusted to balance interests and that resolution is possible. In contrast, when previous interactions were unfair, board members are apt to be less hopeful about the reasonableness of opposing members in resolving divisive issues. Therefore, they may be more apt to resort to forcing issues.

Proposition 6: Fair decision-making procedures will serve to diminish the extent to which goal conflict will result in a forcing issues mode of decision making.

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